Even as CIOs enter their third generation of IT services deals, misconceptions persist about the practice of IT outsourcing. Worse, new illusions have begun to emerge as outsourcing approaches have evolved. Achieving desired outcomes when working with third-party providers depends on clear-eyed understanding of what’s possible and what’s not, what responsibilities remain with the buyer and what new capabilities are required, what’s changed about outsourcing models and what remains the same.
CIO.com talked to IT outsourcing experts who work with IT buyers and vendors to help bust some of the most common myths around outsourcing today — and to aid IT leaders in setting up their outsourcing engagements for success.
Myth: IT outsourcing is dead
There is a commonly held notion that IT outsourcing is no longer a valuable strategy, and cost savings have evaporated. While it’s true that IT outsourcing, as we had come to know it, may indeed be dead, the next generation of outsourcing deals could deliver even greater savings for forward-looking CIOs.
“We have entered the next generation of outsourcing where labor arbitrage and offshoring are being replaced by extreme automation and public cloud adoption,” says Steve Hall, president of EMEA at outsourcing consultancy Information Services Group (ISG) and a partner in its digital solutions group. “The new era of outsourcing is resulting in 40 percent savings or more with rapid ROI as service providers reinvent their offerings to integrate cloud solutions, automation, and modern organizational structures.”
Myth: The old ways still rule
Third-generation outsourcers may think they know everything there is to know about structuring engagements for success, but the reality is that the fundamentals of value creation from outsourcing have changed significantly. Consumption-based pricing is replacing fixed-price models. Contracts designed for efficiency and cost reduction have given way to deals aligned to business outcomes and growth.
“The fundamental mindset needed to succeed is very different, and a contract written for efficiency does not align with a contract that needs to drive growth,” says Jimit Arora, partner in Everest Group’s IT services research practice. “Smart clients recognize the limitations of previous templates and are willing to make changes. Clients that want to simply re-purpose because they think it is ‘old wine in new bottle’ are going to struggle with ineffective contracts.”
Myth: My outsourcer will deliver me innovation
The typical outsourcing deal is built to reduce disruption and risk associated with major change. Indeed, both the buyer and service provider account teams are incentivized to protect the status quo, says Bob Cecil, principal with KPMG’s Shared Services & Outsourcing Advisory. Service providers may offer innovation from their R&D-related efforts; however, customers must contract for innovation in new ways and create a culture within the engagement that encourages it.
Myth: Agile and DevOps are not possible when outsourcing
The digital era demands faster adoption and increased agility and both IT outsourcing customers and service providers must adapt. “Companies and their providers that do not embrace this new paradigm will be left behind and it will impact their businesses,” Hall says. “Create a strategic program with your key providers, bring them into your strategy, and develop your digital future together. Companies cannot do it all alone; strategic providers are critical to making the leap to the agile enterprise.”
Myth: Outcome-based pricing is for everyone
While most clients will say they are ready to pay for outcomes, what they really want is output-based or transaction-based pricing, says Arora. “It is a rare client that can link outsourcing value into business outcomes beyond cost savings. Creating programs that align to true business outcomes are difficult when an IT service provider has control over only part of the input. “Even when they can, there ends up being disagreement over who really contributed to the business outcome,” says Arora. “Consequently, clients may take outcomes but can rarely align that to what it means and the price they are willing to pay to achieve that outcome.”
Myth: Outsourcing IT means outsourcing responsibility
This is perhaps the most enduring of outsourcing myths. “Nothing can be further from the truth,” says Ollie O’Donoghue, research director with outsourcing research firm and consultancy HfS Research. “There are a plethora of outsourcing [horror] stories that involve a business handing over control of their IT to a provider much to their lament.”
“Active client involvement to ensure provider performance through governance and collaboration is essential to ensure the results anticipated in the outsourcing relationship are achieved,” says Hall of ISG. Typical service governance costs amount to 5 to 9 percent of the annual contract value of the deal, according to Cecil.
Myth: A risk-reward partnership increases provider accountability
“‘Skin in the game’ is an approach by outsourcing providers to convey an interest in a partnership, with both sides sharing risk and reward,” says Marc Tanowitz, managing director at business transformation and outsourcing consultancy Pace Harmom. “However, we often see that when outsourcing providers accommodate these models, it is generally for incremental upside rather than a true risk-reward framework. The reality is that outsourcers are not in the risk-taking business; they are for-profit organizations interested in margin growth.”
Myth: Companies that outsource IT lose their best employees
There has always been the risk of employee loss, with those who are fearful or uncertain about the impact choosing to leave the organization or the shift of internal employees to the provider. However, both possibilities have become less likely in recent years.
“A meaningful and empowered organizational change and communications program is the best mitigation for the loss of key people and the growth of misperceptions about the sourcing,” says Hall. “The best advice is to communicate to employees early and often the benefits of outsourcing and help them understand how they will be a part of the change.”
In addition, service providers today only rarely rebadge client’s existing staff as their own. “In most areas, service providers have already built out their core offerings and are not looking to invest in anchor clients and rebadge employees,” says Cecil.
Myth: Automation is the key to future outsourcing savings
Many clients assume that robotic process automation and other forms of automation will unlock the next generation of savings in their outsourcing deals.
“While automation creates tremendous value, nine times out of ten, automation is being applied to an inefficient process which results in a faster and cheaper inefficient process,” Arora says. It’s not a silver bullet. Only automation combined with business process transformation can enable breakthrough value. “If done correctly,” says Arora, “the environment is simplified or digitized to the extent that you probably don’t even need to outsource it anymore.”
Myth: The provider will cover the capital costs of new delivery
The days of utilizing IT outsourcing as a form of capital re-engineering by spreading such costs out over the life of the contract are largely over. “Service providers will charge for upfront transition costs directly,” says Cecil, noting that “service provider transition costs are sometimes lower than a comparable captive build due to embedded competencies.”
Myth: Outsourcing is getting easier
As IT outsourcing has become more mainstream, some assume it has become commoditized. That’s not the case, says Pace Harmon’s Tanowitz, who has encountered clients asking for best-in-class templates to create an outsourcing deal quickly.
“The reality is that outsourcing isn’t standardized and every deal is unique to each client’s business, technical, functional, and financial requirements. And that just addresses the deal structure,” Tanowitz says. Once the outsourced operations begin, things get even more complicated. The retained responsibilities may not be the same activities as performed in the current state. The skills required to govern an engagement aren’t necessarily the same as those required to manage the operations. Internal lines of responsibility can become blurred.
Long story short: Outsourcing isn’t getting any easier. “It is still a transformational and complex business transaction that needs to be diligently planned and managed,” Tanowitz says.
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